This is a chapter from For and Against the
State, John Sanders and Jan Narveson eds. Copyright 1996 by
Rowman and Littlefied Publishers, Inc. Reprinted by permission of the
publisher. List price $23.95 paperback, $62.50 hardback; orders may
be placed by calling 1 800 462 6420. What follows is based on the
version on my hard disk and may differ in details from the published
chapter.

Anarchy and Efficient
Law

More than twenty years ago, Professor (now Judge)
Richard Posner suggested that many features of the common law could
be explained by the conjecture that it was a set of legal rules that
maximized economic efficiency.[0]
To what degree the conjecture is correct is still a matter of debate,
but, true or false, it has played a major role in the development of
the economic analysis of law.

One weakness in Posner's argument was and is the
absence of a plausible mechanism to generate efficient Common
Law.[1]
What he and his supporters offer instead is extensive analysis of the
common law as it actually exists, designed to show that its rules are
close to the rules that would have been chosen by an economist
attempting to maximize economic efficiency. Lacking a compelling
theory, they offer empirical evidence--although a considerable
addition of economic theory is required to argue that the rules
observed to exist are the efficient ones.

My project in this chapter is the mirror image of
Posner's. The legal system I will be describing does not exist, so I
cannot observe its rules.[2]
What I will be proposing is a theoretical analysis of why that legal
system, if it existed, could be expected to generate efficient
rules.[3]

Law as a Private
Good

Imagine a society with no government. Individuals
purchase law enforcement from private firms. Each such firm faces
possible conflicts with other firms. Private policemen working for
the enforcement agency that I employ may track down the burglar who
stole my property only to discover, when they try to arrest him, that
he too employs an enforcement agency.

There are three ways in which such conflicts might
be dealt with. The most obvious and least likely is direct violence-a
mini-war between my agency, attempting to arrest the burglar, and his
agency attempting to defend him from arrest. A somewhat more
plausible scenario is negotiation. Since warfare is expensive,
agencies might include in the contracts they offer their customers a
provision under which they are not obliged to defend customers
against legitimate punishment for their actual crimes. When a
conflict occured, it would then be up to the two agencies to
determine whether the accused customer of one would or would not be
deemed guilty and turned over to the other.

A still more attractive and more likely solution
is advance contracting between the agencies. Under this scenario, any
two agencies that faced a significant probability of such clashes
would agree on an arbitration agency to settle them-a private court.
Implicit or explicit in their agreement would be the legal rules
under which such disputes were to be settled.

Under these circumstances, both law enforcement
and law are private goods produced on a private market. Law
enforcement is produced by enforcement agencies and sold directly to
their customers. Law is produced by arbitration agencies and sold to
the enforcement agencies, who resell it to their customers as one
characteristic of the bundle of services they
provide.[4]

The resulting legal system might contain many
different law codes. The rules governing a particular conflict will
depend on the arbitration agency that the enforcement agencies
employed by the parties to the conflict have agreed on. While there
will be some market pressure for uniformity, it is logically possible
for every pair of enforcement agencies to agree on a different
arbitration agency with a different set of legal
rules.[5]

Indeed, one could have more diversity than that.
Suppose there is some small group within the population with
specialized legal requirements. An example might be members of a
religious sect that forbade the taking of oaths, in a society where
conventional legal procedure required such oaths. Such a group might
have its own enforcement agency and let that agency negotiate
appropriate legal rules on its behalf. Alternatively, an agency might
produce a specialized product for members of the group by negotiating
agreements under which those customers, if involved in litigation,
were not required to swear the usual oaths.

As this example suggests, the potential legal
diversity of such a system is very large; in principle, a different
set of legal rules might apply between every pair of persons. In
practice, such diversity will be constrained by costs of negotiation
and by costs of legal diversity. The transaction costs of separately
negotiating a different law code between every pair of persons would
be prohibitively high, so it is likely that each pair of enforcement
agencies will agree on a single law code interpreted by a single
arbitration agency, with provisions for occasional variances of the
sort described above.

Legal diversity has substantial costs. If, for
example, contract terms enforceable against customers of agency A may
be unenforceable against customers of B, that makes it more difficult
and expensive for firms to draw up satisfactory contracts. Such costs
will provide an incentive for arbitration agencies to adopt more
uniform law, to be balanced against the incentive for non-uniform law
provided by the differing desires of different customers.

Generating Efficient
Law

Suppose a set of law codes of the sort I have
described exists, and that that there is some potential change in the
legal rules prevailing between two enforcement agencies that would
yield net benefits to their customers, and thus improve the
efficiency of the legal system. If the change benefits both sets of
customers, it is in the interest of the enforcement agencies either
to persuade their arbitration agency to make the change or to shift
to one that follows the superior set of rules. If it benefits the
customers of one agency but imposes costs on the customers of the
other, with net costs smaller then net benefits, it is in the
interest of the two agencies to agree to the change, with the loser
compensated either directly or by some other change elsewhere in the
legal rules. In practice, since it is the arbitration agencies that
specialize in legal rules, we would expect them to try to identify
all such improvements and include them in the legal codes they offer
to their customers.

This argument suggests that any change in the
existing set of codes that would produce a net improvement will
occur. The result should be a set of legal codes that are
economically efficient in the conventional sense.[6]

That result must be qualified in several ways. To
begin with, in a world of non-zero information and transaction costs,
an enforcement agency does not perfectly internalize the welfare of
its customers, since it cannot engage in perfect discriminatory
pricing. Furthermore, negotitions between enforcement agencies are
not costless, so some opportunities for mutual gain may go
unexploited. For these reasons, what we would expect is not a
perfectly efficient set of legal rules but a set of legal rules with
tendencies towards efficiency. Where a legal change benefits almost
everyone we would expect to see it, but where it generates both
substantial benefits and substantial costs, we would expect the
system to do an imperfect job of balancing costs and benefits, and
thus to at least occasionally get the wrong answer. One additional
reason why the result will fall short of complete efficiency will be
discussed later in this chapter.

Competition or
Monopoly

Readers familiar with the economic literature on
efficiency may notice that my argument owes more to Coase than to
Marshall. I have relied on the idea that parties will negotiate
towards efficient contracts, rather than on the conventional analysis
of a competitive industry. The reason for that choice is that this
marketplace, despite the very large number of buyers and sellers, is
not competive in the sense necessary for the standard economic proofs
of efficiency.

To see why, let us eliminate from our analysis the
intermediaries, the enforcement and arbitration agencies, and
consider the market for legal agreement in terms of the individual
producers and consumers of that good. Each individual wishes to buy
the assent of every other individual to some legal code or codes, in
order that future disputes between them, if they occur, may be
peacefully resolved. Each individual is thus both a buyer and a
seller of legal assent, buying from and selling to every other
individual.

The reason that the large number of buyers and
sellers does not produce a competitive market is that the goods they
are selling are not substitutes. I desire legal agreement with both A
and B; if I am equally likely to be involved in a dispute with
either, I may have the same value for legal agreement with each. But
getting A's agreement to apply some legal rule in disputes with him
does not eliminate the value to me of B's agreement with regard to
disputes with him, so the two are not substitutes. Unlike the case of
an ordinary good, I cannot simply agree with A on a price and then
buy all the agreement I want from him. It follows that despite the
large number of participants, the interaction is essentially one of
bilateral monopoly. Only A can sell me his assent to legal rules
between me and him, and only I want to buy it.

Because of this, a conventional analysis of a
uniform good sold at a single price by all sellers and to all buyers
does not work for this market. One way of seeing this is to try to
construct such an analysis:

Consider a particular legal change, a shift from
strict liability to negligence for some class of cases. The shift
benefits defendants at the expense of plaintiffs. If total benefits
are larger than total costs, summed over all plaintiffs and
defendants and including not only direct costs and benefits when
litigation occurs but also all of the associated indirect benefits
and costs,[7]
then the change increases economic efficiency.

When A and B agree to a negligence rule for
disputes between them, they are agreeing to two things: that A's
liability will depend on A's negligence when A is the defendant, and
that B's liability will depend on B's negligence when B is the
defendant. For purposes of analysis, those are separate agreements;
one could imagine one without the other.[8]
We may think of A buying from B (at a positive price) B's assent to
the rule for cases in which A is the defendant and B the plaintiff,
and B buying from A (at a positive price) A's assent to the rule for
cases in which B is the plaintiff and A the defendant.

Assume, for simplicity, that every pair of
individuals is equally likely to become involved in a
dispute[9]
and that the nature of the potential disputes is the same across
individuals, so that the value to A of legal assent from B is the
same as the value to him of legal assent from C, D, etc. Parties
differ, however, in their value for consuming and cost of producing
legal assent. Thus A may be willing to pay, if necessary, up to two
dollars each to buy agreement from B, C, D, ... to a negligence rule
that will apply when A is the defendant. B may be similarly willing
to pay up to three dollars to each of the others. Meanwhile, A may be
willing to sell his assent, to agree to a negligence rule in cases
where he is the plaintiff, for any price above one dollar, and B
similarly for any price above two dollars. Following the analogy to
an ordinary good, we would say that A values the assent of others at
$2 per person, B values it at $3 per person. A's cost of producing
assent is $1 per person, B's cost is $3 per person. The efficient
rule is for each party to sell his assent to anyone who values it at
more than its cost, thus maximizing the gains from trade. If B values
assent at more than its cost to A (as he does: $3>$1) it is
efficient for A to agree to accept a negligence rule if he sues B. If
A values assent at less than its cost to B (as he does: $2<$3) it
is efficient for B not to agree to accept a negligence rule if he
sues A.

Suppose, in analogy to an ordinary market, that
each seller specifies a price at which he will sell assent to anyone
willing to pay, and that each buyer than buys assent from anyone
selling it at a price less than the buyer's value. Will this produce
the efficient result?

It will not. Consider the situation from the
standpoint of A. If he offers to sell his assent at $1 to any buyer,
the result will be efficient, since any buyer who values it at more
than $1 (A's cost) will buy it. But A will get no benefit from the
transaction, since he is selling the good for its cost to him; all of
the gain from trade is going to the buyer. If A raises his price to
$2, some potential sales (to buyers with a value between $1 and $2)
will be lost, but the remaining sales (to buyers with a value greater
than $2) will be made at a gain for A of $1 each. Exactly what price
maximizes A's net gain will depend on the distribution of values
among the other sellers, but it will be more than $1. So the result
will be inefficient: buyers who value A's assent at more than its
cost but less than its price will not buy.

This is the familiar deadweight problem of a
single price monopoly. A monopolist maximizes his profit at a price
above his cost, eliminating some efficient transactions. It seems out
of place here because we seem to be dealing with a market of many
buyers and many sellers. But one seller cannot substitute for
another, so it is really a market with a very large number of
bilateral monopolies.

One could reverse the form of the transaction by
having sellers state a price and buyers decide whether to buy or not.
The result would be essentially the same. Buyers would state a price
below their real value, giving up some (efficient) transactions in
order to increase their gain on the remaining transactions. This time
we would call the situation monoposony instead of
monopoly.

If this analysis is correct, and I believe it is,
conventional models of perfect competition do not apply to the market
for legal agreement. It is more appropriately modeled as bargaining
among the parties buying ans selling legal assent, as in the previous
section. Such a model implies an efficient outcome subject to the
limits imposed by bargaining costs.

In practice, a number of features of the situation
are likely to hold down those costs. In many cases, the optimal rules
(ex ante , before an actual dispute has occurred) are the same
for almost everyone. This is particularly likely to be the case if
the bargaining is over symmetrical rules. My agreement to accept a
court that operates under negligence rules makes me worse off when I
am the plaintiff, but better off when I am the defendant. If
negligence is a significantly more efficient rule, it is likely that
most people will prefer it.

A second reason is that I must pay for the
advantages of a favorable legal rule not only in the process of
negotiating it but also in the price of transactions with others who
will be bound by it. Suppose, for example, I manage to get a
"favorable" legal rule for conflicts between me and any attorneys I
hire: if they advise against settling and I lose the case, I can sue
them for malpractice with a good chance of winning. One consequence
of that rule will be to raise the cost to me of hiring a lawyer. In
this and in many other cases, a "favorable" legal rule, like a
"favorable" term in a contract, must be paid for in every transaction
it applies to, and if it is inefficient the price is likely to be
more than it is worth. That is part of the reason why, as Judge
Posner and others have argued,[10]
the legal system is a poor instrument for income
redistribution.

These arguments suggest that the bargaining
problems implied by the bilateral monopoly nature of the market for
legal assent should not be insuperable, that bargaining among
enforcement agencies representing groups of customers ought to be
able to produce something close to an efficient outcome. Absent some
theoretical structure more powerful than Coasian bargaining, it is
hard to be more precise than that.

The Baseline Problem

In my discussion so far I have assumed the
existence of some baseline, some initial set of law codes from which
bargaining begins. While the location of that base line does not
affect the argument for the efficiency of the eventual equilibrium
legal rules, it does affect what that equilibrium looks like. Many
steps in the process of bargaining towards efficiency will involve
some parties agreeing to a legal change that makes them worse off, in
exchange for some balancing benefit. If we start with a rule of
strict liability, to take the example above, a shift to negligence
may require individuals who prefer the latter rule[11]
to pay individuals who do not for their assent. If we start with a
rule of negligence, a shift in the other direction will require
payments the other way. So although the baseline does not determine
the efficiency of the outcome, it may well affect the associated
distribution of income.[12]

It is not immediately obvious what that base line
is.[13]
If two enforcement agencies fail to agree on a mutually acceptable
arbitrator to settle their dispute, after all, the result is not that
the dispute is resolved according to the UCC or the Delaware
Commercial Code but that it is resolved by force.

This suggests that the ultimate baseline is the
solution to a bilateral monopoly bargaining game among the agencies.
Each agency can threaten to refuse to agree to any arbitrator,
subjecting both to the costs of occasional violence, or at least of
ad hoc negotiation to avoid violence. Each knows that the other would
prefer even a rather unfavorable set of legal rules to no agreement
at all. Each knows that if no agreement is reached, they are both at
risk of losing their customers to other agencies that have been more
successful in negotiating agreements.

The situation is analogous to a union management
negotiation or the negotiations determining borders, trade policies,
and the like between neighboring countries. While there is no good
theoretical account of exactly what determines the outcome of
bilateral monopoly bargaining, experience suggests that some
tolerably stable equilibrium usually exists. Most unionized firms
manage to settle their differences without lengthy strikes, and most
nations are at peace with most of their neighbors most of the
time.[14]

So we may imagine the market for law as starting
out with a set of default rules between each pair of protection
agencies, representing the result of bargaining backed by threats of
refusal to agree on an arbitrator. From there, the agencies bargain
to an efficient set of rules. The distributional outcome is the
result of an implicit threat game between the agencies; the
allocational outcome is the result of a (logically subsequent)
bargaining game to move the agencies (and their customers) from the
starting point to the Pareto frontier.

Experience suggests that there is enormous inertia
in mutual threat games of this sort. National boundaries do not move
half a mile one way or the other each time one nation becomes a
little richer or a little more powerful. In practice, an
anarcho-capitalist society will probably be built not so much on an
ongoing mutual threat game as on a mutual threat game played out in
the distant past. That suggests that, once the initial equilibrium
has been established, the success of a protection agency will be
based mainly on its ability to produce protection for its customers,
not its ability to defeat rivals in open warfare.

While it is always possible for one firm to
threaten to withdraw from its arbitration agreement with another
unless the terms are renegotiated de novo , such threats are
unlikely to be either common or successful. Other agencies have a
strong incentive to insist on basing their bargaining on the existing
rules, in order to prevent the costs both of continual renegotiation
and of violence when negotiations break down.

The stability of a status quo in part reflects the
influence of Schelling Points, outcomes recognized by both parties as
unique, upon the outcome of bargaining.[15]
Where the alternative to agreement is costly, almost any agreement is
better than none, so both parties have an incentive to look for
alternatives that they can converge on. This suggests the possibility
that if anarcho-capitalist institutions evolve out of an existing
state-run legal system, the rules of that legal system might function
as the status quo from which further bargaining preceded. Whether or
not such rules are efficient, they are familiar to the parties and
they specify answers to most of the relevant questions. They
therefore provide a potential point of initial agreement from which
to conduct further bargaining.

Market Failure in the Market for
Law

I have argued that the market will tend to
generate efficient law, for much the same sort of reasons that
markets in general tend to generate efficient outcomes, although the
argument depends on Coasian bargaining rather than perfect
competition. But even if markets tend towards efficiency, that
tendency is limited by various forms of market failure. Are there
forms of market failure to which this market is particularly
vulnerable, and, if so, what are their implications?

The answer, I think, is that there is a special
sort of market failure relevant to this market. It is plausible to
imagine a pair of enforcement agencies bargaining to an outcome close
to the set of rules that maximize the net welfare of their customers.
It is not I think plausible, pace Coase, to imagine a set of a
hundred enforcement agencies bargaining together to a single outcome
maximizing the welfare of all of their customers. So we can expect
the legal rules between A and B to maximize their joint welfare, even
to maximize the joint welfare of all of the clients of their
enforcement agencies, but we cannot expect the rules applying between
A and B to maximize the joint welfare of everyone, including
customers of other enforcement agencies.

It follows that the rules will be optimal only
when the legal rule between A and B produces no net third party
effect on C, C being a customer of some other agency. In many cases
this seems plausible, at least as a reasonable approximation. The
rule that determines what happens if A breaks his contract with B, or
breaks into B's house, or breaks B's arm, should have relatively
little effect on C.[16]

Consider, however, intellectual property law. When
B agrees to respect A's intellectual property, the result is an
increased incentive for A to produce such property, which may benefit
others who use it. Such benefits will not be taken into account in
the negotiations that determine whether or not B makes such an
agreement. The result will be a lower than optimal level of
intellectual property law.

Indeed, the result may well be no protection for
intellectual property at all. To see why, imagine that A, a producer
of intellectual property, is bargaining with B, a consumer, for
protection. If they agree on protection, B will be liable to pay A
$10 for each copy of A's computer program that B makes. What are the
cost and benefits of such an agreement.

The most obvious benefit is that A will receive
$10/copy. This, however, is exactly balanced by the cost to B of
paying $10/copy. If these were the only costs and benefits, agreement
and disagreement would be equally efficient.

There are at least two other costs and one other
benefit. One cost is that B will make fewer copies of the program
than if copying were free--perhaps he will put a copy on his desktop
machine but not on his portable. Perhaps he will buy copies of two of
A's programs, but not a third, since it is worth only $5 to him. This
cost is the familiar deadweight cost of copyright--the inefficiency
due to the difference between the (positive) price of making an
addition copy to the user and the (zero) marginal cost of permitting
an additional copy to the copyright owner, resulting in an
inefficiently low number of copies.

A second cost is the cost of enforcing the
agreement. Keeping track of what copies A has made will be costly,
perhaps impossible, and any resulting dispute will lead to expensive
litigation.

To balance these costs there is an important
benefit: The incentive that A has to write computer programs if he
will be paid for them and does not have if he will not. If we were
considering the question of requiring or not requiring all consumers
of A's intellectual property to pay for it, that benefit might well
outweigh the costs we have described, making copyright protection for
programs economically efficient. After all, if A does not write any
programs there will be nothing for B to copy.

But we are considering the question not with
regard to the whole world but only with regard to B. The additional
revenue A will receive as a result of B being covered by his
copyright is very small, and will produce only a very small increase
in output. That increase will benefit everyone who uses A's programs,
but only the small part of that benefit that goes to B will be
relevant to the negotiation between them. It follows that the benefit
is vanishingly small, implying net costs, hence no
protection.

The result is similar but less extreme if we
consider negotiation, not between individuals, but between
enforcement agencies. The agency will take into account not merely
the benefit to B from the increased output due to B being bound by
A's copyright, but the benefit to all of its customers due to the
increased output from all of them being bound by A's copyright. The
result is still only a small fraction of the total benefit from
copyright law, assuming that there are many enforcement agencies each
serving only a small fraction of the population, but a larger
fraction than in the case of individual negotiation. The fraction
becomes larger still if we allow for the possibility of copyright
negotiations among groups of enforcement agencies, with each agreeing
to recognize the copyrights of the customers of all of the others if
they will all agree similarly. Such negotiations would be analogous
to the negotiations among nations by which international intellectual
property rights are now established.

Even allowing for the possibility of such
multiparty negotiations, our result, although weaker, still remains;
we would expect an inefficiently low level of protection for
intellectual property. We might well get no protection at all. This
raises two questions, both outside the range of this chapter. One,
whether intellectual property protection is desirable, and if so how
desirable, has been discussed at some length in the intellectual
property literature.[17]
The other, whether the equivalent of intellectual property protection
could be provided in other ways, for instance by contract, is
discussed (in the context of computer networks and encryption) in a
forthcoming article of mine.[18]

Similar problems will arise with pollution law,
where A's right to sue B for polluting his air results in a reduction
of B's emissions and thus an external benefit for A's neighbor C.
They may well arise in other important contexts as well. In all of
these cases, we would expect the legal rules generated by the private
market to be inefficient. Whether they will be less efficient than
the rules currently generated by courts and legislatures is not
clear. Pace Posner, we have no good theoretical reason to expect
those legal rules to be efficient either.

The Evidence

While there are no modern anarcho-capitalist
societies with legal system to be analyzed, there are a number of
real world institutions, past and present, that are in some ways
analogous. Evidence on the working of such institutions may help us
answer two related questions about the private market for law:
whether conflicts would be settled by law rather than violence and
whether the resulting legal rules would be efficient.

Consider the settlement of legal claims between
insurance companies at present. Company A's client runs into and
injures Company B's client, giving the latter a possible tort claim
against the former. The two companies can resolve the dispute at a
low cost by settling out of court, provided they can agree on an
outcome (or an arbitrator), or they can settle it at a high cost in
court.

Their situation is analogous to the "arbitrate or
fight" decision faced by a private enforcement agency every time one
of its clients has a legal conflict with a client of another agency.
There too, there is a low cost solution (arbitration) which depends
on an agreement between the two agencies and an alternative
(violence) with high costs for both parties. In both cases, the
parties (insurance companies and enforcement agencies) can expect to
have many such conflicts with each other, so they are engaged in a
repeated game in which considerations such as reputation will play a
large role.

The argument is not, of course, limited to auto
accidents. It applies wherever parties are faced with the decision to
settle or litigate, since that is a bilateral monopoly problem of the
same sort I have been describing. The evidence suggests that the
overwhelming majority of parties in such cases
settle.[19]

Evidence on settlement rates provides some reason
to believe that, under the institutions I have described, almost all
disputes would be settled peacefully, but it does not tell us what
the rules under which disputes were settled would be like. The
literature on norms as a private substitute for law suggests that
such institutions might produce a reasonably efficient set of
rules.

In his book Order Without Law, Robert Ellickson
described his investigations into how conflicts were settled in
modern day Shasta County, California. He found that interactions
between neighbors, with regard to straying cattle and many other
things, were controlled not by law but by a system of norms, a
private law code having no connection to courts, legislatures, or any
other agency of state power. When a rancher was informed that one of
his animals was trespassing, he was expected to apologize, retrieve
the animal, and take reasonable precautions to keep it from happening
again. If significant damage had been done, the rancher was expected
to make up for the damage.

The system was self enforcing. If a rancher
consistently let his animals stray, or failed to offer to make up for
significant damages, the victim would respond by initiating true
negative gossip, spreading the word that that particular rancher was
not behaving in a proper neighborly fashion. If that failed to work,
straying animals could be transported far from the victim's (and
owner's) property, imposing significant costs on the owner who had to
retrieve them. In extreme cases trespassing animals might even be
deliberately injured. The one thing good neighbors did not do, even
under severe provocation, was go to court.

Straying cattle were not the only thing to which
legal rules were irrelevant. California has quite detailed laws
specifying under what circumstance one of two adjoining landowners
can build a fence between their properties and charge part of the
cost to his neighbor. Landowner's in Shasta county build fences, and
their neighbors sometimes end up paying for them. But what fences get
built and who pays for how much of the cost are unaffected by what
ought to be the relevant law. Nor do such norms apply only in
modern-day Shasta County. Ellickson's examples of societies with such
norms included orchard men in the Pacific Northwest, whalers in the
19th century, and modern American academics.

Ellickson's central thesis was that close-knit
groups tend to develop efficient norms. He concluded that while
formal law is important and useful in human affairs, it is less
important and less useful than generally believed. In a wide variety
of situations, people not only succeed in resolving their conflicts
without recourse to law, they do it by mechanisms that work
considerably better than the legal system.

I have discussed elsewhere the reasons why I
believe that his thesis is a plausible one, and offered some evidence
that the norms he describes are in fact efficient.[20]
The relevance of that discussion to this chapter is that the system
of norms and norm enforcement that he describes is a simpler version
of the sort of private market for law discussed in this chapter.
There are no middlemen or arbitrators; everyone is his own
enforcement agency; the only available court is the court of (local)
public opinion. But the structure of the market for norms is the same
as the structure of the market for law. Each person can choose
whether to act in a neighborly fashion towards each other person, and
each pair of persons must in some way reach agreement on what that
implies. If individuals fail to agree (or violate their agreements),
the result is costly conflict. If, as Ellickson argues, such a
structure tends to generate efficient norms, that is at least some
evidence that a similar structure would tend to generate efficient
laws.

Efficiency, Justice and
Liberty

The attentive reader, and especially the attentive
libertarian reader, will have noticed that I have said nothing about
what the laws generated by the market will be, other than efficient.
In particular, I have said nothing about whether those laws will be
consistent with either justice or liberty. That omission was
deliberate. My purpose here is to discuss what outcomes we can expect
a competitive market for law to produce, not what outcomes we want it
to produce. This is an essay in economics, not moral
philosophy.

Whether these outcomes will be consistent with
either justice or liberty depends on whether either justice or
liberty is economically efficient. In the case of liberty, I think
there is good reason to believe that, as a general rule, it is. A
considerable part of libertarian writing, my own
included,[21]
as well as a good deal of economic theory from Adam Smith on, defends
the thesis that, on the whole, leaving people free to run their own
lives maximizes total human happiness--for which economic efficiency
may be considered a rough proxy.[22]

Whether justice is efficient is a harder problem,
and comes in two parts. The first is the question of whether the
rules implied by justice are themselves efficient rules; to that I
have no answer, since I have no theory of justice to offer other than
that implied by individual liberty. The second is the relation
between individuals' beliefs about justice and their preferences for
law.

Suppose that almost everyone in a society shares
certain beliefs about justice-perhaps that the conviction of
innocents is a very bad thing, to be avoided even at high cost, or
that murderers should be executed, or that children should not be
executed, even for murder. Those beliefs will affect but not
determine what laws the people in that society demand. Justice is
only one of the things people value; an individual might favor a
legal rule he considers unjust if he thinks it benefits him. So we
would expect the efficient set of legal rules generated by the market
to represent some compromise between the legal rules that would be
efficient absent specific beliefs about justice and the rules implied
by those beliefs. To put it differently, beliefs about justice affect
the value to individuals of being under particular legal rules, which
affects what legal rules are efficient, which affects what legal
rules the market will produce.

Anarchy, Efficiency and the Common
Law

I have argued that there is reason to expect a
system in which legal rules are generated by firms competing in a
private market to produce efficient rules. Richard Posner has argued
that there is considerable empirical evidence to suggest that the
actual rules of anglo-american common law are efficient. This raises
an obvious and interesting question: can the mechanisms I have been
describing explain the observed efficiency of the common
law?

I do not know the answer to that question.
Certainly some forms of competitive law have contributed to the
creation and development of the common law. The common law had its
origin in the legal system of Anglo-Saxon England, whose early form
involved a large element of private enforcement and private
arbitration.[23]
It evolved in an environment of multiple court systems--church,
royal, and local--where litigants had at least some control over
where their disputes were resolved. Some common law rules originated
as private norms, and I have argued that norms are produced on
something like a competitive market. Some rules may have been
borrowed from the medieval Fair Courts, which had some of the
characteristics of the system I have described.

It is thus possible that what Posner observes in
present day common law is fossilized efficiency, produced by
institutions that no longer exist[24]
and preserved by the conservative nature of the common law. That
conjecture is consistent with the observation that the efficiency of
the common law seems to have decreased over time, at least in this
century, with the long retreat from freedom of contract providing the
most striking example. It is also consistent with Posner's claim that
it is common law, not legislated law, which tends to be efficient.
But it would require a much more extensive knowledge of the history
and content of the common law than I have to say whether such a
conjecture provides a plausible account of such efficiency as modern
common law possesses.[25]

In any case, the principal purpose of this chapter
is not to offer a solution to the puzzle of why the common law is
efficient, supposing that it is. My purpose is to show why the law
generated by the institutions of private property anarchy would tend
to be efficient, and to explore some of the limitations of that
tendency. Although the arguments I offer do not imply anything like a
perfectly efficient legal system, they may provide better reasons to
expect efficient law under anarchy than we have to expect efficient
law under other forms of legal system, including the sort we now
have.

David Friedman

References

Breyer, "The Uneasy Case for Copyright: A Study of
Copyright in Books, Photocopies, and Computer Programs, 84 Harvard
Law Review 281, 292-301 (1970).

Buchanan, James M. 1974, review of The
Machinery of Freedom: Guide to a Radical Capitalism by David D.
Friedman, Journal of Economic Literature XII, 3 (September
1974), pp. 914-915.

Benson, Bruce, The Enterprise of
Law.

Cowen, Tyler 1992, "Law as a Public Good: The
Economics of Anarchy," Economics and Philosophy, 8 (1992), pp.
249-267.

[0]The book was the first
(1972) edition of The Economic Analysis of Law. So far as I know,
this was the first appearance in print of the conjecture. In the
current (1992) edition Posner writes "the theory is that the common
law is best (not perfectly) explained as a system for maximizing the
wealth of society."Posner prefers the term "wealth maximization," but
uses it in a sense corresponding to conventional ideas of economic
efficiency. For a more detailed discussion of such ideas, see
Friedman (Price Theory) Chapter 15, Posner (1992) esp. pp.
13-16.

[1]Some
arguments for such a mechanism can be found in Rubin (1977) and
Priest (1977), and Posner (1992, pp. 254-255, 535-536. For arguments
on the other side, see Rubin and Bailey (1994).

[2]I will offer some
evidence based on existing markets with a similar economic
structure.

[3]The original for of
this argument appeared in Friedman (1973), pp. . Interested readers
will also find there, and in the current (1989) edition, discussions
of other problems raised by an anarcho-capitalist society, including
defense against foreign states and stability against the
reintroduction of the state.

[4]Economists are
accustomed to the idea that the principal justification for
government is as a producer of public goods. Law enforcement,
although it has some public good elements, is both crowdable--it
costs a police force more to protect all the citizens of a town than
to protect half of them--and excludable. Arbitration is an ordinary
private good, although one of its outputs and inputs, information in
the form of precendents, shares the public good characteristics of
other forms of information. See Landes and Posner (1976,
1979).

[5]A single arbitration
agency might supply different law codes to different customers, so
the number of law codes could be greater than the number of
arbitration agencies. If, on the other hands, customers valued the
simplicity and predictability of uniform law, many arbitration
agencies might choose to adopt identical, or at least very similar,
law codes.

[7]Such costs and benefits
include costs of precautions taken by parties to avoid liability and
benefits due to accidents prevented by such precautions.

[8]In many legal systems,
legal rules are not symmetrical between parties. Even in our legal
system, that is true if one of the parties is a government protected
by sovereign immunity, or a minor, or some other party with special
status.

[9]If one wanted to drop
this assumption, one could do so by introducing a "quanity"
[pi]ij, representing the probability of a dispute
between i and j. A uniform price P for legal assent would then be per
unit, making the price at which i bought assent from j
P[pi]ij.

[10]Posner (1992) p.
474.

[11]Perhaps something
about their circumstances makes them particularly likely to be
accidental (but not negligent) tortfeasors.

[12]Imagine, for example,
the baseline rules with regard to race that we might expect if an
anarcho-capitalist society had somehow been established in the
American south in the 1840's. Even if the system succeeded in
bargaining its way to the (efficient) outcome of freedom for slaves,
it would presumably be freedom on very unfavorable terms.

[13]This problem was
first called to my attention by James Buchanan, in a perceptive
review of Friedman (1973). See Buchanan (1974).

[14]For one approach to
understanding how the solution to such conflicts is determined and
maintained, see Friedman (1994,2).

[15]Friedman (1994,2),
Schelling (1960).

[16]Little, but not none.
A might break B's arm without first ascertaining B's enforcement
agency. If so, the fact that C's enforcement agency has obtained
severe penalties for assault in its negotiations with A's agency may
provide some protection to B.

[18] D. Friedman, "A
World of Strong Privacy: Promises and Perils of Encryption,"
forthcoming in Social Philosophy and Policy, also available from the
author.

[19]Danzon and Lilliard
(1983) found that fewer than 10% of malpractice claims were tried;
Viscuzi (1986) found that 95% of product liability claims that were
not dropped were settled either before or during trial. Department of
Transportation research on bodily injury and uninsured motorist
claims found that "less than 1% of all claimants went all the way to
a verdict." (Shapo (1984) quoting from 1 Department of
Transportation, Automobile Personal Inury Claims 121 (1970)). Hammitt
(1985) reported that, of the bodily injury cases in their study, only
about 1% were tried to a verdict; about an additional 1/2% of the
cases settled during trial. I do not know what fraction of the cases
in any of these studies were conducted by insurance companies against
insurance companies. I conjecture that, if one could separate out
such cases, the settlement rates would be even higher, because of the
discipline imposed by repeat dealing.

[20]David Friedman, "Less
Law than Meets the Eye," a review of Order Without Law, by Robert
Ellickson, The Michigan Law Review vol. 90 no. 6, (May 1992) pp.
1444-1452. In that review I suggest limitations to the efficiency of
norms corresponding to those offered here with regard to the
efficiency of privately generated law.